Euro Gets a Boost from Lagarde

May 23, 2022

Short-term rates continue to move against the dollar; we continue to believe that U.S. recession fears are overblown; April Chicago Fed National Activity Index will be reported

ECB President Lagarde is validating recent hawkish comments from her colleagues; firm May German IFO business climate survey was reported; Israel is expected to hike rates 25 bp to 0.60% 

President Biden announced the creation of the Indo-Pacific Economic Framework; Biden also said he will review existing tariffs on Chinese imports; Korea reported weak trade data for the first 20 days of May

The dollar remains under pressure.  DXY is trading near 102.144, the lowest since April 26.  Key level to watch is 101.80 as a break below would set up a test of the April 21 low near 99.818.  We still view this as a correction within the longer-term dollar rally but confess surprise at how far the dollar has fallen from the early May peak.  Similarly, the euro is trading at the highest since April 26 near $1.0680.  Here, a break above $1.0710 would set up a test of the April 21 high near $1.0935.  USD/JPY remains heavy near 127.50 despite the improved risk sentiment.  Sterling is trading at the highest since early May near $1.26 and is about to test the May 4 high near $1.2640.  Looking ahead, a break above $1.2735 would set up a test of the April 21 high near $1.3090.


Short-term rates continue to move against the dollar.  The 2-year yield differential with Germany has fallen to 222 bp, the lowest since mid-March, while the differential with the U.K. has fallen to 108 bp, the lowest since early May.  Lastly, the differential with Japan stands near 268 bp and has not moved as much as the other two.  With the U.S. 2-year yield trading in very narrow ranges, most of the movement has come from the other side.  For instance, the German 2-year yield is trading at new highs for this cycle near 0.40%, driven in large part by continued ECB hawkishness.  At some point, the pendulum of market sentiment is likely to swing back in the dollar’s favor but for now, the market is seeing very little resistance as it takes the dollar lower. 

We continue to believe that U.S. recession fears are overblown.  U.S. yields have fallen sharply from the early May peaks as some soft data have raised concerns about the economic outlook.  Our two favorite indicators – the 3-month to 10- year yield curve and the Chicago Fed National Activity – suggest otherwise.  While the slope of the curve has fallen to 182 bp vs. the 231 bp peak in early May, it remains far from inversion.  Likewise, the Chicago Fed NAI (see below) remains far from recessionary readings.  We believe that as the U.S. outlook improves, yields will resume rising and that should help the dollar get some traction in the coming days. 

April Chicago Fed National Activity Index will be reported.  Because it is a good predictor of economic downturns, this series should command more and more attention as the Fed tightens.  Consensus see 0.50 vs. 0.44 in March.  If so, the 3-month average would fall slightly to 0.49 vs. 0.58 in March.  That March 3-month average was the highest since May 2021 and we note that a modest decline to 0.49 would still be the second highest since May 2021 and well above the -0.7 reading that typically signals a recession.  Bostic and George speak today. 


ECB President Lagarde is validating recent hawkish comments from her colleagues.  Specifically, she said the bank is likely to exit negative rates by the end of Q3.  This supports current market pricing for liftoff July 21 with a 25 bp hike, followed by another 25 bp September 8 that results in a zero deposit rate.   Follow-up hikes October 27 and December 15 are fully priced in that would take the deposit rate to 0.5% by year-end.  This is unchanged from last week.  Similarly, the swaps market is still pricing in a terminal policy rate of 1.5%.  To be clear, market pricing for the ECB has not shifted after Lagarde’s remarks and yet the euro got another leg higher.  At some point, the subdued ECB outlook should weigh on the euro but for now, the FX market is happy to take the dollar lower.  De Cos, Holzmann, Nagel, and Villeroy all speak today. 

Firm May German IFO business climate survey was reported.  Headline came in at 93.0 vs. 91.4 expected and 91.9 in April, with current assessment rising to 99.5 vs. 96.8 expected and 97.3 in April and expectations rising to 86.9 vs. 86.5 expected and 86.8 in April.  Of note, all three April readings were revised up a tick.  This was the second straight improvement in the headline reading and offers hope that the German economy may be bottoming.  May flash PMIs tomorrow and June GfK consumer confidence Wednesday should offer some more insight. 

Bank of Israel is expected to hike rates 25 bp to 0.60%.  A handful of analysts look for a larger 40 bp move.  At the last meeting April 11, the bank delivered a hawkish surprise by starting the tightening cycle with a 25 bp hike to 0.35% vs. 15 bp expected.  It noted that “The pace of raising the interest rate will be determined in accordance with activity data and the development of inflation, in order to continue supporting the attainment of the policy goals.”  The bank saw the policy rate at 1.5% in Q1 23.  Since then, inflation accelerated to 4.0% y/y in April, the highest since June 2011 and further above the 1-3% target range.  Swaps market sees the policy rate peaking near 2.25% in the next 24 months but we see upside risks. 


President Biden announced the creation of the Indo-Pacific Economic Framework.  Along with a dozen of the largest regional economies, the U.S. is clearly hoping to fill the void that it created when President Trump pulled out of the Trans-Pacific Partnership.  However,  unlike the TPP, this new framework does not include any tariff reductions.  Rather, it is focusing on a rather fuzzy set of goals.  The joint statement said “This framework is intended to advance resilience, sustainability, inclusiveness, economic growth, fairness, and competitiveness for our economies.  Through this initiative, we aim to contribute to cooperation, stability, prosperity, development, and peace within the region.”  Nevertheless, it is a strong statement that is meant for an  audience of one – China.  

President Biden also said he will review existing tariffs on Chinese imports.  He said he would discuss the matter with Treasury Secretary Yellen after returning from his current trip to Asia, adding “We did not impose any of those tariffs -- they were imposed by the last administration.”  This is a pretty big concession.  Though the economic dialogue with China has moved to the back burner, having those tariffs in place gave the U.S. some leverage over China.  If the Biden administration does consider the move, we suspect it would be along the lines of a temporary suspension as the U.S. should not give up that leverage.  Stay tuned.

Korea reported weak trade data for the first 20 days of May.   Exports rose 24.1% y/y, but average daily exports rose only 7.6% y/y as the total was boosted by two more working days this year.  If sustained for the entire month, exports would slow sharply from 12.9% y/y in April.  Recent data suggest the regional slowdown in trade and activity continues and that was clearly reflected in this trade data.  

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